Articles Posted in Oil and Gas Law

A recent case that was decided by the Texas Court of Appeals in San Antonio illustrates the problems when mineral owners sign a “standard” form for their oil and gas lease and why they should consider getting the opinion of an experienced Texas oil and gas attorney before they sign. Failing to do so could end up costing you money every month.

The decision is Chesapeake Exploration, LLC v. Hyder. The Court, in a unanimous decision written by Justice Sandee Bryan Marion, ruled that, despite the claims of the well operator, post-production costs could not be deducted from the mineral owner’s royalties, based on the specific language of the lease before the Court. This particular lease was most definitely not a standard form and appeared to have been carefully drafted by the Hyder’s attorney.

The Hyder lease was executed on September 1, 2004 with another oil company, and then the lease was assigned to Chesapeake Exploration LLC. The leased premises consisted of two tracts of 1,037 acres and 948 mineral acres in Johnson County and Tarrant County. The lease allowed Chesapeake to drill from existing well sites adjacent to the leased premises, as well as within the leased premises itself. For the wells on the leased premises, the Hyders were paid a precentage royalty. For wells outside the leased premises, the Hyders were to be paid a specified percentage as overriding royalties.

In October 2013, the American Petroleum Institute and the American Fuel & Petrochemical Manufacturers (AFPM) submitted information to the Environmental Protection Agency (EPA) asking the EPA to lower the 2013 cellulosic biofuel quota because oil refiners would be forced to buy millions of dollars in unnecessary “credits” for cellulosic biofuel because the actual biofuel was unavailable.

In a very helpful (and surprising) turn, on January 23, 2014, the EPA announced that it would reconsider the 2013 quote due to this new information. The EPA determined the information was relevant and met statutory requirement for granting a reconsideration.

The government has hoped that cellulosic biofuel would replace ethanol, which has caused complaints over driving up prices of corn and the damage to engines. However, costs in producing cellulosic biofuels have delayed production, and so production hasn’t kept pace with government quotas. AFPM President Charles Drevna pointed out that the 2013 quota for cellulosic biofuels was six million gallons, which is absurd when only one million gallons were produced. Since they obviously cannot buy biofuel that doesn’t exist, EPA requires oil refiners to buy “credits” instead. API estimated that buying these credits would cost oil refiners $2.2 million in 2013. Mr. Drevna explained that in March 2013 the EPA set the 2012 quota at zero. In reality, these credits are a penalty for not complying with a law that is impossible to comply with!

A decision from the United States Tax Court in December 2013 has interesting implications for Texas oil and gas leases and Texas mineral owners. In Dudek v. Commissioner, the Tax Court examined the characterization of lease bonus and whether bonus is eligible for depletion allowance.

The Dudek decision dealt with three main issues: 1) whether the bonus payment received by the taxpayer pursuant to an oil and gas lease is taxable as ordinary income or as a capital gain; 2) whether the taxpayer is entitled to a depletion deduction; and 3) whether the taxpayer is liable for an accuracy-related penalty under section 6662(a) for a substantial understatement of income tax.

Michael Dudek, the taxpayer and the petitioner in this case, is a certified public accountant and an attorney licensed to practice law in Pennsylvania. In 1996 and 1998, Dudek and his wife, Brenda, bought a total of 353 acres of land. The Dudeks leased the oil and gas rights to EOG Resources Inc., receiving a 16% royalty and a bonus of over $883,000. As many of you know, bonus is consideration for the primary term of the lease and is not contingent on any extraction or production of oil or gas. The Dudeks reported the lease bonus as a long term capital gain on their income tax return.

The Texas Supreme Court will hear a new case involving royalties on natural gas. Those involved with oil and gas law in Texas will be paying attention, as the case will probably be important. The case is is Occidental Permian Ltd. v. Marcia Fuller French et al, and it is one of the first cases to deal with allocation of the cost of removing carbon dioxide from produced gas following tertiary recovery of that gas with CO2. The appeal was heard by the Eastland Court of Appeals of Texas in October 2012.

The Facts

The Plaintiffs in the trial court, Ms. French and others, were the lessors on two different oil and gas leases in Scurry County and Kent County, Texas. Occidental Permian began injecting wells on these leases with carbon dioxide (CO2) in 2001 in order to boost oil production. As a result, the well produced natural gas that was about 85% CO2. Occidental had the gas treated off site to remove the carbon dioxide and sold the resulting gas. The extracted CO2 was sent back to the well to be reinjected. Occidental paid royalties on the gas after it was treated, and also deducted the treatment costs from the Plaintiffs’ royalties.

A case is winding its way through the courts could be especially important in light of the large number of new oil and gas pipelines being constructed in Texas today. The case was heard by theTexas Court of Appeals in Tyler last year and is currently being heard by the Texas Supreme Court.

The case, Enbridge Pipelines (East Texas) LP v. Gilbert Wheeler, Inc., concerns landowners seeking property damages for the pipeline company’s violation of a pipeline right of way easement agreement. There are two main issues. The first issue is whether the cost to restore the property is the proper measure of damages for the breach of contract alleged by the landowners. The second issue is whether the Court of Appeals erred by holding that the landowners waived their claims by failing to submit a jury question on the nature of the property injury.

Factual Background

The Texas Court of Appeals in Beaumont, Texas recently decided a very interesting the case that has huge implications for Texas land and mineral owners: Environmental Processing Systems LC v. FPL Farming Ltd. The Texas Supreme Court recently heard oral argument on this case.

The Facts

As many Texas mineral owners are aware, salt water is often produced by an oil well in conjunction with the oil. Generally, this salt water is required by law to be collected and taken to saltwater injection wells that are licensed by the Texas Railroad Commission. The salt water is then injected back into the subsurface, where it came from. But one cannot always control where the saltwater goes after it is injected.

The Houston Court of Appeals in Texas recently addressed the issue of surface owners rights in the case of Key Operating & Equipment Inc. v. Will and Loree Hegar. The case involves the use of the surface of the Plaintiffs’ land by an oil and gas operator. In Texas, the owner of the minerals generally has an implied easement for reasonable use of the surface in order to explore, develop and extract the minerals. In this case, the mineral owner wanted to make continued use of a road on the Plaintiffs’ surface estate to access minerals on other tracts, after that surface estate had been severed from its minerals, and after the minerals under the Plaintiffs” tract and the minerals under the other tracts had been pooled.

The Defendant, Key Operating and Equipment owned mineral rights and operated wells on two tracts of land (the Richardson and Rosenbaum-Curbo tracts) in Washington County, Texas since the late 1980’s. The mineral leases allowed for pooling, and in 2002, Key pooled mineral interests in the two tracts, and used the road across the Curbo tract to access their two producing wells on the Richardson tract. At the time of the suit, there was no longer a producing well on the Curbo tract. In 2002, the Hegars bought the surface of the Curbo tract and a 1/4 interest in the minerals. They knew about the lease and the road–which they used themselves to get to their house. They objected, however, when Key drilled a new well on the Richardson tract and used the road more frequently. Mr. Hegar stated, “We’re trying to raise a family and we can’t do it with a highway going through our property.” So in 2007, they sued Key for trespass and asked for a permanent injunction to prohibit Key from using the road. The Hegars claimed that no oil is actually being produced from the Curbo tract and Key only pooled the interests in order to continue to use the access road. Key claimed that the Curbo oil is migrating towards the Richardson tract, and that is why they pooled the two tracts.

The trial court agreed with the Hegars and permanently enjoined Key from using the road “for any purpose relating to the extraction, development, production, storage, transportation, or treatment of minerals produced from an adjoining” tract.

Faced with a rising tide of sweeping municipal legislation banning hydrocarbon extraction, mineral owners and oil and gas operators are taking the fight to court. The Independent Petroleum Association of New Mexico, along with an individual landowner and two limited liability corporations, are suing Mora County, New Mexico, alleging that the ordinance passed by the county violates the Plaintiff’s constitutional rights and exceeds the authority of the county council.

The Mora County ordinance, the first of its kind in the United States, is described by the county as a measure to protect the local water sources and the communities that rely on them. However, the ordinance specifically targets oil and natural gas extraction. The suit alleges that the real purpose of the ordinance, rather than protection of natural water sources, is to prevent lawful development of oil and natural gas resources within Mora County. The ordinance prohibits the extraction of water for use in the extraction of subsurface oil or gas, and also prohibits importing water into the county for that purpose. The ordinance further provides that no permits, licenses, privileges or charter issued by any state or federal agencies that violate the ordinance will be valid. The ordinance passed by Mora County is a variation on an ordinance developed by Pennsylvania attorney Thomas Linzey and adoption of similar ordinances is being considered by dozens of communities across the country.

The Independent Petroleum Association argues that the ordinance violates the substantive due process rights of the organization’s members and exceeds the authority of the county council. They further argue that the ordinance violates fundamental property rights, and that the ordinance does not meet the strict scrutiny standard because the ban is not narrowly tailored to serve a compelling governmental interest. In particular, they note that even though the stated purpose of the ban is to protect the water supply, the ban applies only to hydrocarbon extraction while ignoring the agricultural industry, a source of significant water pollution.

An interesting case involving a Texas oil and gas lease was decided recently by the Texas Court of Appeals in El Paso. The case was Community Bank of Raymore v. Chesapeake Exploration LLC and Anadarko Petroleum Corporation. The issue was whether the lessee’s right to extract minerals found deeper than the stratum or level below the deepest producing well in a particular unit terminated when the lease’s primary term expired.

The oil and gas lease in question covered 16,000 acres, split into four blocks, located in Loving County, Texas. In Block 2 of the leased area, Chesapeake Exploration drilled 13 wells, the deepest of which was at 5,672 feet when the primary term of the lease expired on January 26, 2010. Community Bank of Raymore (“CBR”) requested that Chesapeake release its mineral rights below the depth of the deepest well, but Chesapeake refused. CBR file suit for breach of the lease.

CBR argued that the Pugh clause applied, which terminates an oil and gas lease at the end of the primary term as to any portion of the leased land which is not being produced. Chesapeake disagreed, relying on the continuous development clause, saying the Pugh clause was thus never triggered because Chesapeake developed Block 2 and paid royalties from existing wells in that block. Chesapeake said that its continued development of Block 2 was “sufficient to maintain the undeveloped, deep-lying formations beyond the primary term and satisfy the lease’s continuous development requirement.”

In October 2013, the U.S. Supreme Court granted certiorari in the case of Chamber of Commerce et al v. EPA et al. The case will decide the question of “(w)hether the EPA [Environmental Protection Agency] permissibly determined that its regulation of greenhouse gas emissions from new motor vehicles triggered permitting requirements under the Clean Air Act for stationary sources that emit greenhouse gases.”

The grant of certiorari followed Texas Attorney General Greg Abbott’s petition to the Court in April 2013, along with 11 other state attorneys general. The 11 other states involved, in addition to Texas, are Alabama, Florida, Georgia, Indiana, Louisiana, Michigan, Nebraska, North Dakota, Oklahoma, South Carolina and South Dakota. The attorneys general argued in their petition that the EPA violated the Constitution as well as the federal Clean Air Act by “concocting” its greenhouse gas regulations without Congressional authorization. Attorney General Abbot said that the regulations are threatening Texas jobs and employers and the EPA is a “runaway federal agency”. He was pleased the Obama administration would have to defend these regulations before the Supreme Court.

Organizations representing the oil and gas industry were also pleased that the Supreme Court decided to take this case. These organizations include the American Petroleum Institute and the American Petrochemical & Fuel Manufacturers. The issue doesn’t effect just the energy and manufacturing industries. Millions of other stationary sources could be affected by strict permitting requirements according to the president of the National Association of Manufacturers, who said that the regulations threaten the global competitiveness of the U.S.